What you need to know about Ireland's economic crisis is that it's not about Ireland, a small country of slightly more than 4 million people and an economy of roughly $200 billion. It's about Europe. For decades, Europe has pursued two great political projects. One is the democratic welfare state, designed to improve economic justice through various social safety nets. The other is European unity, symbolized by the creation in 1999 of a single currency - the euro - now used by 16 countries. The fact that both contributed to Ireland's troubles suggests that Europe could be on the brink of a broader crisis.
Ireland's problems are not isolated, and if they portend a wider meltdown, this would mark a dangerous new phase in the global economic turmoil that began in 2007. Europe represents about one-fifth of the world economy, comparable to the U.S. share. If the continent relapsed into recession, worldwide economic nationalism would intensify, as the already-weak global recovery faltered and countries competed for scarce sales. For example: Europe buys about 25 percent of America's exports, which would suffer. Protectionism and predatory behavior would increase.
The rescue package (about $90 billion in outside funds) just negotiated by Ireland, other members of the European Union and the International Monetary Fund would prop up Ireland's loss-ridden banks. The aim is to contain the fallout by showing that Europe can cope with its own problems. But the rescue involves much bravado, because some lenders (Portugal, Spain, Italy) are themselves heavily indebted and possible candidates for future bailouts. Even Germany and France have huge gross debts, 76 percent and 86 percent, respectively, of their economies in 2009. How much new debt can be piled atop old debt?
That Ireland, after Greece, has come to grief is ironic. Until recently, it was admiringly dubbed the Celtic Tiger for emulating Asian countries in attracting foreign investment - Intel and others - and achieving rapid export-led growth. From 1987 to 2000, annual economic growth averaged 6.8 percent; unemployment fell from 16.9 percent to 4.3 percent. But then solid growth gave way to a housing boom and bubble whose collapse left Irish banks awash in bad loans.
One cause was easy credit occasioned by the euro. With its own currency, Ireland could regulate credit. If it seemed too loose, the Central Bank of Ireland could raise interest rates. Adopting the euro meant Ireland surrendered this power to the European Central Bank (ECB), which set one policy for all euro countries. The ECB's rates, though perhaps correct for France and Germany, were too low for Ireland and some others. Moreover, financial markets pushed rates on government bonds of euro countries down to lower German levels. In 1995, Ireland's rates were more than a percentage point higher than Germany's; by 2000, they were almost identical.
Ireland might have offset easy credit by increasing taxes or cutting spending. But this would have required great self-restraint. The housing boom produced a torrent of tax revenue from construction, home sales and wealth-induced consumer spending. From 1996 to 2006, home prices almost quadrupled. Construction spending went from 11 percent to 21 percent of the economy. Government budgets were in surplus, despite increased social spending and higher government salaries. "When I have the money, I spend it," said one former finance minister. "When I don't, I don't."
So now the reckoning. In Ireland, the burst housing bubble left a massive budget deficit and lifted unemployment to 14 percent. Most European economies suffer from the ill effects of some combination of easy money, unsustainable social spending and big budget deficits. Countries are interconnected, so there are spillover effects. European banks - led by British, German, French and Belgian banks - have $500 billion in loans and investments in Ireland, reports the Financial Times. Large losses could snowball into a broader banking crisis.
Europe's challenge is no longer just economic. It's also social and political. Cherished values and ideals are under assault. The euro, intended to nurture unity, has bred discord, as countries assign blame and argue over sharing costs. The social contract is being rewritten, with government benefits and protections being cut. In Ireland, the governing coalition seems doomed; one minority party has withdrawn its support.
The rescue of Ireland, as with Greece before, represents a gamble that Europe can arrest growing doubts and win the patience of bondholders and voters: persuading the investors not to continue dumping bonds (those of Ireland and other countries) in panic, which raises interest rates and could precipitate a self-fulfilling financial collapse; and persuading ordinary citizens to tolerate austerity (higher unemployment, lower social benefits, heavier taxes) without resorting to paralyzing street protests or ineffectual parliamentary coalitions. Whether the gamble will succeed is unclear, as are the potentially chaotic consequences if it doesn't.